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To Groupon Or Not To Groupon: Making The Most Of Daily Deals

Erik Sherman

Pete's New Haven Style Apizza in Washington, D.C., had just opened its third location, and the owners needed to bring in new people fast. Naturally, they tried a Groupon daily deal promotion: customers could pay $10 and get a coupon for $20 in food at the newest restaurant, no restrictions.

"We sold a huge amount quickly," said co-founder Joel Mehr—6,000 certificates, to be exact. Business swelled at the start and then again at the end of the promotion in September 2011. Then things slowed again. With $90,000 worth of redeemed meals translated into actual hard food costs of $18,000, Mehr says, "I don't think it was a bad one-time thing to do." But Pete's won't repeat the experience in the near future.

"We're not doing any more promotions with anyone of this style, mainly because we have no control over when we discount people coming into the restaurant," Mehr said. Having to honor discounts on a busy weekend night was counterproductive because the restaurant was already busy with "people in line waiting to pay full price for pizza."

It could have been worse. Since daily deal sites such as Groupon and LivingSocial became hot last year, there have been high-profile stories of restaurants that lost thousands from promotions gone wrong. And yet, many establishments have successfully used them. Differences between winners and losers are clear strategic use of promotions; negotiation with the deal company; and smartly-constructed offerings that make money (or at least don't lose it).

Daily deal sites get merchants to offer heavily-discounted specials. The site sends the promotion out to its e-mail list of subscribers. Would-be customers purchase the special in advance. The deal site collects the money and pays a portion to the restaurant (often amortized over a multi-month life of the promotion). The customer presents the appropriate coupon on arrival for the food or service.

Aside from anecdotes in newspapers and on websites, how have restaurants taken to daily deals? A recent study by food-industry market research firm Technomic showed that about 40 percent of the 400 restaurants it surveyed had participated in a daily deal promotion. The experience of the restaurants was surprising.

"Conventional wisdom is that it's a good deal for the consumers and a bad deal for the restaurants," said Technomic executive vice president Robert Goldin. That's because the deal sites supposedly take half of the revenue and control too much of how the promotion will work. But, as Goldin put it, "conventional wisdom is usually not wisdom."

About half of the establishments had overall positive experiences, with 69 percent seeing new customers and 53 percent getting at least some repeat business from the new customers. "It's working for some but not others," he says. You can see the contrast in the single case of Zapatista, a Mexican restaurant with three Chicago locations.

In January 2010, when its second location was four months old, Zapatista offered a $40 coupon for $20 through Groupon to build traffic to the new site. "We sold 4,000 of them, and it was overwhelming at times," says president David Yanda. "It served its purpose of getting our name out, but from a business sense of making any money, that didn't happen."

The coupons represented $160,000 of food at list price represented. Roughly 27 percent food and an 80 percent redemption rate meant an actual outlay of about $35,000. Because the deal ran from January into the restaurant's busy summer season and the new location was naturally growing its own customer base, it wasn't possible to determine how much the promotion contributed to long-term improved traffic. Under the deal terms, Groupon kept too much of the revenue to make the experience economically worthwhile on its own.

And yet, Yanda is in the middle of another Groupon promotion. Why? Management at Zapatista has become smarter about how to use daily deals and robust competition for Groupon has made effective negotiation a lot easier.

The most recent promotion started in September 2011 to generate traffic and word-of-mouth for the third location. Yanda structured prix fixe deals ± $29 for two people and $89 for six—that included an appetizer, entrée, beverage and dessert. Because the non-entrée items had relatively high-margin items, much of the discount was off items that had low food costs. Zapatista could structure a meal that let the restaurant actually make money on every customer.

Groupon needs to close business deals to keep growing and to keep competitors at bay. It isn't in a good position to walk away, so Yanda negotiated an arrangement under which Groupon's take was "in the neighborhood" of 25 percent. That was far better than the 50 percent it has often tried to get from merchants and increased the money Zapatista could make per deal.

Furthermore, Yanda limited redemption times to avoid busy weekend nights, when tables could be filled with customers paying full price, and capped the total number. As a result, Yanda not only got a promotion that fulfilled an important goal—increase foot traffic at a new location, though attracting people to an additional part of the day or new menu offering would also make sense—and also offered a positive ROI.

That wouldn't surprise Goldin. By time-limiting discounts; focusing on parts of the menu that can support discounting; and, most importantly, learning how competition is forcing daily deal sites to be more accommodating, he said restaurateurs can make effective use of discount sites as one of their marketing tools without losing their shirts in the process.

Erik Sherman is a writer primarily covering business and technology. He’s written for the New York Times Magazine, Newsweek and Advertising Age, among others.